The interaction between monetary and fiscal policies in Turkey: An estimated New Keynesian DSGE model

This paper estimates a New Keynesian open economy DSGE model for Turkey by using Bayesian estimation technique for the period of 2002:q1-2009:q3. It studies fiscal and monetary policy interactions and their role in stabilisation of the economy using a small-scale model following the methodology outlined in Lubik and Schorfheide (2007). The general features of the model can be summarised as follows: Calvo style nominal price rigidities, perfect exchange rate pass-through, complete international asset markets, rule of thumb price setters and distortionary taxation.The parameter estimates show that the monetary authority reacts to inflation but only weakly reacts to the output gap. The degree of interest rate smoothing is high. Fiscal policy has contributed to the debt stabilisation but there is no evidence on active fiscal stabilisation of output gap.

Research highlights► I examine the interactions between fiscal and monetary policies using a DSGE model. ► Monetary authority reacts to inflation but only weakly reacts to the output gap. ► The degree of interest rate smoothing is high. ► Fiscal policy has contributed to the debt stabilisation. ► There is no evidence on active fiscal stabilisation of output gap.